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The Elliott wave principle (wave principle) is a form of technical analysis that some investors use to forecast trends in the financial markets and other collective human activities. Ralph Nelson Elliott published his "Wave Principle" monograph in 1938, which presented his observations of well-defined "waves" or patterns in the Dow Jones Industrial Average. In later works Elliott published evidence that these patterns reflect the Fibonacci sequence: 0, 1, 1, 2, 3, 5, 8, 13, 21, etc.

The wave principle describes how financial markets behave. This description begins with the premise that collective investor psychology (or crowd psychology) moves from optimism to pessimism and back again; these swings create patterns, as evidenced in the price movements of a given market.

Specifics of the theory

According to the wave principle, markets move in five waves up and three waves down. As these waves develop, the larger price patterns unfold in a self-similar fractal geometry. Within the dominant trend, waves 1, 3, and 5 are called "impulse" waves, and each impulse wave itself subdivides in five waves. Waves 2 and 4 are "corrective" waves, and subdivide in three waves. In a bear market the dominant trend is downward, so the pattern is reversed -- five waves down and three up.

Criticism

The wave principle has its critics. They claim it is too vague to be useful since it cannot always identify when a wave begins or ends, and that Elliott wave forecasts are prone to subjective revision. Skeptics also say that if the theory is true, widespread knowledge of it among investors would lead to distortions of the very patterns they were trying to anticipate, rendering the method useless. This same argument can be (and is) made against other predictive methods that are based on public, market-wide data.

References

"The Elliott Wave Principle" by Frost & Prechter. Published by New Classics Library P.O. Box 1618 Gainsville Georgia 30503.

See also

• Business cycle
• Grand supercycle
• The Wisdom of Crowds
• Dead cat bounce

External links

• Elliott Wave Theory - ChartSchool - StockCharts.com
• CyclePro Elliott Wave Rules and Guidelines - Updated 11/1/98
• Elliott Wave International - What Is the Wave Principle?

• Technical analysis